Taking the time to understand your insurance policies, and how they are impacted by coinsurance is well worth the effort. An insurance policy is a complex contract that often contains provisions that assign certain responsibilities to the policyholder, such as a coinsurance clause. Because such provisions are often misunderstood, we have gathered the basics of coinsurance to help eliminate any potential confusion.
How Do You Calculate It?
In the simplest terms, the coinsurance provision in a property policy requires the policyholder to carry a limit of insurance equal to a specified percentage of the value of the property to receive full loss settlement payment at the time of a loss.
Coinsurance applies a penalty for all partial losses when insured’s purchase less insurance than specified by the insurer (whether the property is insured on a replacement cost or actual cost value basis. The majority of losses are partial ones.
For example, a building with a replacement cost value of $1,000,000 and a policy with an 80 percent coinsurance clause must be insured for at least $800,000 to avoid a coinsurance penalty at the time of loss.
Here’s where it gets a bit more complicated: If there is a claim, the formula to determine the recovery is based on the property’s replacement value at the time of loss. If the replacement amount is less than the coinsurance percentage, a penalty is applied, reducing the claim payment. For example, the replacement cost of a building is deemed to be $800,000 at the time of the loss, the policyholder has a $600,000 building limit on his policy and a fire causes $200,000 in damages. The claim is calculated by dividing the amount of insurance purchased ($600,000) by the value at the time of loss ($800,000). This factor (75 per cent) is multiplied by the amount of the loss ($200,000 x .75 = $150,000). In this example, the policyholder would receive $150,000 (less any deductible) for a $200,000 claim.
What Policies Include a Coinsurance Clause?
Commercial property insurance policies typically include a coinsurance clause. The building, business, personal property, and inland marine policies (property floaters, such as the tools floater and Contractors Equipment floater) all contain the coinsurance clause mentioned above. Some policies require 100 percent of the value to be insured.
What can you do to mitigate a coinsurance clause? In some cases, The coinsurance clause included in the policy language can be “suspended” for the term of the policy by adding a stated amount clause endorsement. This is a provision where the insurer and the insured agree that the amount of insurance is adequate and the coinsurance clause will not apply to a loss. A stated amount clause will require a professional appraisal to be on file.
Our Commercial Risk & Insurance Consultants understand coinsurance provisions and can help you review your policies to ensure your coverage meets your expectations. Contact us today to learn more, check out other Frequently Asked Questions or follow us on LinkedIn for more commercial insurance insights.